1. General Course Questions 2. Columbia Sportswear Annual Report Project Questions 3. Chapter 18 Revenue Recognition (using assigned homework) A. Two Conditions for Revenue Recognition (question 2) B. Departures from the Point of Sale Basis (question 6) C. Long term Construction Contracts (?7 & 9, BE 2,3,4,Prob 6) D. Installment Sales & Cost Recovery (BE 7,8,9, 10) E. Cost Recovery (BE 10) 4. Discussion Question #4 Revenue Recognition 5. Return and Review Ch 7 quiz – cash & receivables Intermediate Accounting Intermediate Accounting November 16 November 16 th th , 2010 , 2010 1
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1.General Course Questions 2.Columbia Sportswear Annual Report Project Questions 3.Chapter 18 Revenue Recognition (using assigned homework) A. Two Conditions.
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1. General Course Questions
2. Columbia Sportswear Annual Report Project Questions
Revenue should be recognized at the soon as what TWO conditions are met:
1.
2.
Revenue should be recognized when you have ______ the W______ & P_______ is assured.
Revenue RecognitionRevenue Recognition
Question 2
Sale of product from
inventory
Type of Transaction
Rendering a service
Permitting use of an asset
Sale of asset other than inventory
Date of sale (date of delivery)
Services performed and
billable
As time passes or assets are
used
Date of sale or trade-in
Gain or loss on disposition
Revenue from interest, rents, and royalties
Revenue from fees or
services
Revenue from sales
Description of Revenue
Timing of Revenue Recognition
Chapter 18 Chapter 18 Chapter 10
Revenue Recognition Classified by Type of Transaction
Chapter 14 & others
3
I. Revenue is normally recognized at the point of sale, provided:
A. Revenue can be reasonably ___________, collectibility of the sales price is reasonably assured or the amount uncollectible can be ___________ reasonably.
B. The earnings process is _______; the seller is not obligated to perform significant activities after the sale.
II. Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned.
III. Delayed recognition is appropriate if the
degree of uncertainty concerning the amount of revenue or costs is sufficiently high or
sale does not represent substantial completion of the earnings process.
Timing of Revenue Recognition
4
I. Revenue is normally recognized at the point of sale, provided:
A. Revenue can be reasonably measured, collectibility of the sales price is reasonably assured or the amount uncollectible can be estimated reasonably.
B. The earnings process is complete; the seller is not obligated to perform significant activities after the sale.
II. Earlier recognition is appropriate if there is a high degree of certainty about the amount of revenue earned.
III. Delayed recognition is appropriate if the
degree of uncertainty concerning the amount of revenue or costs is sufficiently high or
sale does not represent substantial completion of the earnings process.
Timing of Revenue Recognition
5
Revenue Recognition Alternatives
6
Departures from the Sale BasisA. Sales with Buyback Agreements - even though title has transferred, if the seller still has the risk of ownership it is not a sale.
B. Sales When Right of Return Exists - do not record
the sale unless all of the following six provisions are met:
(question 6)
1. Sellers _____ is known (fixed or determinable at the date of sale)
2. Buyer's payment is not contingent upon the ______ of product
3. The buyer's obligation is not altered if product is _____/______
4. Buyer is a separate ______ from seller
5. Seller is not obligated to help buyer _______the product
6. Future returns can be _________
C. Trade Loading and Channel Stuffing - practices to book tomorrows revenues today, need to be discouraged.
Departures from the Point of Sale Basis
7
Departures from the Sale BasisA. Sales with Buyback Agreements - even though title has transferred, if the seller still has the risk of ownership it is not a sale.
B. Sales When Right of Return Exists - do not record
the sale unless all of the following six provisions are met:
1. Sellers price is known (fixed or determinable at the date of sale)
2. Buyer's payment is not contingent upon the resale of product
3. The buyer's obligation is not altered if product is stolen/damaged
4. Buyer is a separate entity from seller
5. Seller is not obligated to help buyer resell the product
6. Future returns can be estimated
C. Trade Loading and Channel Stuffing - practices to
book tomorrows revenues today, need to be discouraged.
Departures from the Point of Sale Basis
8
Long-Term ConstructionAccounting Methods
1) Terms of contract must be certain, enforceable.2) Certainty of performance by both parties3) Estimates of completion can be made reliably
1) For short-term contracts 2) Used for long-term contracts only when conditions for percentage completion are not met3) Abnormal contract risks
Percentage-of-CompletionMethod
Completed ContractMethod
Revenue Recognition Revenue Recognition Before DeliveryBefore Delivery
Question 7 & 9 9
10
• Reflect the economic substance of the activities of the company
• I/S: Revenues earned and expenses incurred to reflect the efforts and accomplishments each period. They are not all deferred until the final year of project completion.
• B/S: Value of asset being constructed is adjusted at the end of each period to reflect the amount of revenue recognized on the contract
• Requires the use of estimates• What information do we need?
• Contract revenue• Expenses incurred (or other input or output measures)• Estimated remaining expenses (or other input or output
measures)• Billing and cash from customer
Basic Idea of Percentage of Basic Idea of Percentage of CompletionCompletion
11
“Construction in Process” (CIP)•An Inventory account used to accumulate the amount recognized as Revenue throughout the contract (Similar to a Work-In-Process inventory account, but includes not only cost, but also the gross profit to date)•First the construction costs are recorded in this account as they are incurred•Then the gross profit is added to this account at the end of each period when Revenue is recognized. Thus, the balance in this account then equals the total revenue recognized on the contract to date.•This inventory account is not removed until the construction is complete and title is transferred to the new owner. Then it is offset against Billings on Construction in Process.
“Billings on Construction in Process”•A Contra-Inventory account to CIP, used to accumulate the amount that a customer has been billed and thus recorded in Cash or Accts Rec.•Interim billings are not usually based upon percentage of costs or completion. Thus, the amount billed and recorded in Billings on CIP is not likely to be equal to the revenue recognized, which is the balance in the CIP account.
• “Construction in Process” (CIP) An Inventory account which equals the total revenue recognized on the contract to date.
• “Billings on Construction in Process” A Contra-Inventory account to CIP, used to accumulate the amount that a customer has been billed and thus recorded in Cash or Accts Rec.
• Interim billings are not usually based upon percentage of costs or completion. Thus, the amount billed and recorded in Billings on CIP is not likely to be equal to the revenue recognized, which is the balance in the CIP account.
• At the end of any accounting period, the difference between the balance in “CIP” and “Billings on CIP” will appear on the balance sheet.
1) If “CIP” > “Billings on CIP”, the difference will be reported as an asset2) If “Billing on CIP” > “CIP”, the difference will appear as a liability.
• The two accounts (CIP and Billings on CIP) will equal at the end of the contract. They are closed out against each other when construction is complete and title is transferred to the new owner.
Balance SheetCashAccounts ReceivableInventory: Construction in Process (Cost + Gross Profit = Revenue
recognized to-date on the contract)
Less Billings on Construction in Process (amount billed; amount of cash received and/or still in A/R)
Total amount in Current assets related to the contract will equal the amount of Revenue Recognized to date on the contract (the amount in cash and/or A/R will be offset against Billings on CIP)
Income StatementConstruction RevenueConstruction Costs s Gross profit on Construction efforts
End of Construction when construction is complete and title is transferred to the new owner:
DR: Billings on Construction in process
CR Construction in Process
The total amount invoiced in Billings on CIP will equal the total revenue recognized to-date on the contract at the end which has been captured in the CIP account. Thus the two accounts are closed out against each other as the construction company no longer has title to the asset and the amount invoiced has been recorded in cash and/or Accounts Receivable.
Costs incurred to date = Percent completeMost recent estimated total costs
11
Estimated total revenue x Percent complete = Revenue to be recognized to date
22
Total revenue to be recognized to date less Revenue recognized in PRIOR periods = Current period revenue
33
Current Period Revenue less current costs = Gross profit44
Computing the Revenue & Computing the Revenue & Gross Profit to recognize at Gross Profit to recognize at the end of each period using the end of each period using Percentage-of-CompletionPercentage-of-Completion
Costs incurred during the year $2,880,000 $2,230,000 $2,190,000Estimated costs to complete $3,530,000 $2,190,000 $ -0- total estimated costs $6,400,000 $7,300,000 $7,300,000
Progress Billings during year $3,200,000 $3,500,000 $1,700,000Cash collected during year
What is the percent complete, revenue, and gross profit recognized each year?
Note that Gross Profit is stored in the CIP Account – this is very different from “ordinary” sales transactions, where gross profit is not in any specific account
• A T-account analysis of the CIP account is very useful in answering questions
• For example, you could be told that Daniels Construction incurred $1 million in construction costs on a new contract this year. They expect to incur another $7 million to complete the project. The balance in the CIP account at year end is $1.2 million. What is the total revenue they expect to earn on the contract?
• Answer: 1.2 – 1 = 200,000 in GP recognized• Project is 1/(1+7) or 12.5% complete, so 200,000 / 0.125 =
$1,600,000 in total profit• Since profit is revenues minus expenses, total revenues must
be 1.6 + 8 = $9.6 million
Percentage-of-Completion: the Percentage-of-Completion: the Construction in Progress AccountConstruction in Progress Account
22
Use For Short Term Construction Contracts Or when does not meet criteria for % Completion:1. Terms of contract not certain, or enforceable2. Certainty of Performance by either party is in question3. Realiable estimates to measure % complete are not
available (cost, input or output measures) No revenue, no expense, no gross profit recognized until the project is
actually completed.
Journal entries prepared during the life of contract are the same as those prepared under the percentage-of-completion method with the exception of the last journal entry that recognizes periodic revenue, expense and gross profit.
Instead, the entire revenue, expense and gross profit are recorded at the end of the project.
• Assuming the same numbers as example before, what are the journal entries under the completed contract method?• All journal entries for 2010, 2011, and 2012
would appear exactly as before, except that there would be no revenue recognition journal entry in each year
• Therefore, the balance in CIP at the end of each year would represent only the inventoried construction costs
24
Losses on Contracts
Need to determine if the loss is for the current period or if for the contract overall.
• If on overall profitable contract, recognize the loss in the period incurred via “negative gross profit” (see example Problem 6 year 2011)
• Overall unprofitable contract• Percentage of completion: Recognize entire contract
loss now by “backing out” previous gross profit• Completed contract: Recognize the entire loss now.
What is the theoretical justification for this?
Construction contractors should disclosure:
the method of recognizing revenue,
the basis used to classify assets and liabilities as
current (nature and length of the operating cycle),
the basis for recording inventory,
the effects of any revision of estimates,
the amount of backlog on uncompleted contracts,
and
the details about receivables.
Disclosures in Construction Company Financial
Statements
25
In certain cases companies recognize revenue at
the completion of production even though no sale
has been made.
Completion-of-Production Basis
Revenue Recognition Revenue Recognition Before DeliveryBefore Delivery
Revenue Recognition Revenue Recognition Before DeliveryBefore Delivery
Examples are:
precious metals or
agricultural products.
What is the theoretical justification for this?
26
27
Revenue recognition is deferred when collection of sales price is not reasonably assured and no reliable estimates can be made.
Methods of deferring revenue:
Installment-sales method
Cost-recovery method
Deposit method – cash received prior to delivery or transfer of property. Thus sale is not complete, and cash is recorded as a customer deposit (current liability).
Revenue Recognition After Revenue Recognition After DeliveryDelivery
Generally Generally EmployedEmployed
28
• Recognize income in periods of cash collection rather than at the point of sale.
• Title typically does not pass to the buyer until all cash payments have been made to the seller.
• Recognize both Revenue and Cost of Sales in period of sale, but Gross profit is deferred to the periods of collection.
• Selling and administrative expenses are not deferred.
The Installment Sales The Installment Sales MethodMethod
29
• Installment sales must be kept separate from regular sales
• Gross profit on installment sales must be determinable
• The amount of cash collected from installment accounts by year sold must be known
• Provision must be made to carry forward each year’s deferred gross profit separately
The Installment Sales The Installment Sales MethodMethod
30
Steps to Record Steps to Record Installment SalesInstallment Sales
1. Record initial Installment sale, keeping track of A/R by year sold and noting revenue as “Installment Sales”.
2. Cost of sales and inventory reduction recorded normally, using information to compute Gross Profit rate each year.
3. When closing “Installment Sales and COGS, defer the Gross Profit by year of sale.
4. Record cash collections reducing A/R by year of original sale.
5. Realize Gross profit on cash collected, taking Cash times gross profit rate in year of original sale, and reducing deferred gross profit for the corresponding year.
4. When cash is received, some deferred GP is recognized as revenue:Cash 245,000 Installment A/R (2003) 40,000 Installment A/R (2004) 125,000 Installment A/R (2005) 80,000
• Initial Franchise fee• Revenue recorded when there is:
• Substantial performance• No remaining obligation to refund any cash or excuse
any non-payment of note. Generally assumed to be when franchisee commences operations
• Collection of fee is reasonably assured
• If terms not met, then Unearned Franchise Fees• Often payment is in cash and a LT note
receivable• Continuing Fees
• When earned and receivable.• Often amount must be verified
Franchise RevenueFranchise Revenue
46
On 3/31/09 the Red Hot Chicken Wing Corp. entered into a franchise agreement with Thomas Keller. In exchange for an initial franchise fee of $50,000, Red Hot will provide initial services to include the selection of location, construction of building, employee training and consulting services over several years. $10,000 is payable on 3/31/09, with the remaining $40,000 payable in annual installments. 10% interest on the note (at market rate) is payable annually. In addition, the franchisee will pay continuing franchise fees of $1000 per month for advertising and promotion provided by Red Hot, beginning immediately after the franchise begins operations. Thomas Keller opened his Red Hot franchise for business on 9/30/09
Costs to date $1,000,000 $2,916,000 $4,050,000Estimated costs to complete $3,000,000 $1,134,000 $ -0-Progress Billings during year $900,000 $2,400,000 $1,200,000Cash collected during year $750,000 $1,750,000 $2,000,000
What is the percent complete, revenue, and gross profit recognized each year?
Percentage-of-Percentage-of-Completion: ExampleCompletion: Example
To record completion of project:DR Billings on CIP 4,500,000
CR Construction in process 4,500,000
Over the life of the contract, the total credits to “Billings on CIP” will equal the total amount billed to the customer, which is the total revenue received over the life of the contract.
• Assuming the same numbers as example before, what are the journal entries under the completed contract method?• All journal entries for 2003, 2004, and 2005
would appear exactly as before, except that there would be no revenue recognition journal entry in each year
• Therefore, the balance in CIP at the end of each year would represent only the inventoried construction costs
62
2003:Construction in Progress (CIP) 1,000,000
Cash, A/P, etc.1,000,000
A/R 900,000Billings 900,000
Cash 750,000A/R750,000
Entries above same as for % Completion. No entry to record revenues and expenses.